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JPMorgan Chase & Co. /2005 Annual Report 77
< (60)
(20) > < (10)
(10) > < 0
0 > < 10
10 > < 20
20 > < 30
30 > < 40
40 > < 50
50 > < 60
60 > < 70
70 > < 80
80 > < 90
90 > < 100
100 > < 110
> 140
(30) > < (20)
(40) > < (30)
Daily IB market risk-related gains and losses
Year ended December 31, 2005
Number of trading days
Average daily revenue: $37.3 million
0
5
10
15
20
25
30
35
$ in millions
5
10
15
20
< 0
0 > < 20
20 > < 40
40 > < 60
60 > < 80
> 100
$ in millions
Number of trading days
Daily IB VAR less market risk-related losses
80 > < 100
110 > < 120
(60) > < (50)
(50) > < (40)
130 > < 140
120 > < 130
Loss advisories
Loss advisories are tools used to highlight to senior management trading
losses above certain levels and are used to initiate discussion of remedies.
Economic value stress testing
While VAR reflects the risk of loss due to unlikely events in normal markets,
stress testing captures the Firm’s exposure to unlikely but plausible events in
abnormal markets.The Firm conducts economic-value stress tests for both its
trading and its nontrading activities using multiple scenarios for both types of
activities. Periodically, scenarios are reviewed and updated to reflect changes
in the Firm’s risk profile and economic events. Stress testing is as important
as VAR in measuring and controlling risk. Stress testing enhances the under-
standing of the Firm’s risk profile and loss potential, and is used for monitor-
ing limits, one-off approvals and cross-business risk measurement, as well as
an input to economic capital allocation.
Based upon the Firm’s stress scenarios, the stress test loss (pre-tax) in the IB’s
trading portfolio ranged from $469 million to $1.4 billion, and $202 million
to $1.2 billion, for the years ended December 31, 2005 and 2004, respectively.
The 2004 results include six months of the combined Firm’s results and six
months of heritage JPMorgan Chase results.
Earnings-at-risk stress testing
The VAR and stress-test measures described above illustrate the total economic
sensitivity of the Firm’s balance sheet to changes in market variables. The
effect of interest rate exposure on reported Net income also is critical. Interest
rate risk exposure in the Firm’s core nontrading business activities (i.e.,
asset/liability management positions) results from on– and off–balance sheet
positions. The Firm conducts simulations of changes in NII from its nontrading
activities under a variety of interest rate scenarios, which are consistent with
the scenarios used for economic-value stress testing. Earnings-at-risk tests
measure the potential change in the Firm’s Net interest income over the next
12 months and highlight exposures to various rate-sensitive factors, such as
the rates themselves (e.g., the prime lending rate), pricing strategies on
deposits, optionality and changes in product mix.The tests include forecasted
balance sheet changes, such as asset sales and securitizations, as well as
prepayment and reinvestment behavior.
Earnings-at-risk also can result from changes in the slope of the yield curve,
because the Firm has the ability to lend at fixed rates and borrow at variable
or short-term fixed rates. Based upon these scenarios, the Firm’s earnings
would be affected negatively by a sudden and unanticipated increase in
short-term rates without a corresponding increase in long-term rates. Conversely,
higher long-term rates generally are beneficial to earnings, particularly when
the increase is not accompanied by rising short-term rates.